Size And PE Factor Toward Vietnams Stocks Return

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An Analysis on Relations of Price-Earnings Ratios and Market Capitalization to Anomaly Returns

Advisor: Le Hong Nhung, MBA Student: Ton That Hue Tri

- International University -- School of Business Administration -

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Value Investment

Style Investment Growth Investment

Technical Analysis

Market Neutral

Event-Driven

Distress Investment

Global MacroContrarian

Tape Reading

Gorilla Trading

Day Trading

Scalping Trading

Merger ArbitrageLong/Short

Short Bias

Volatility Arbitrage 130-30 Funds

Fixed Income Arbitrage

Quantitative Directional

Triangular Arbitrage

Interest Rate Parity

Size Value Factors Sectors Liquidity

P/E P/B P/CF Leverage

Size Effect P/E Effect

Combination Effect of P/E and Size

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Content

Chapter 1 - IntroductionChapter 2 - Literature ReviewChapter 3 - Study Design & MethodologyChapter 4 - Result Analysis & Discussion Chapter 5 - ConclusionAppendices

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Chapter 1 - Introduction

Background ContextObjectivesImplications of the Study

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00 01 02 03 04 05 06 07 08 090

200

400

600

800

1000

1200

Back Ground Context

Chapter 1 – IntroductionBackground ContextObjectivesImplications of the Study

Chapter 2 - Chapter 3 - Chapter 4 - Chapter 5 - Appendices

I don’t know what happened there

Nothing happened here

People got top of the world here, and …

People committed suicide here.

Vietnam’s stock market is breath-taking!!!

6

Objectives



Investigate P/E Effect

Investigate Size Effect

Investigate Combination Effect of P/E and Size

3 Main Targets

2 Sub Targets

Find correlations between Size and P/E

Give comment to Efficient Market Hypothesis

7

Implications of the Study



Test the applicable characteristic of theories from advanced countries

Proof for Efficient Market Hypothesis

For Academic Community

Meaningful information for investment strategy

Anchor to develop style investment strategies

For Investment Community

8

Chapter 2 - Literature Review

Efficient Market HypothesisAnomalies and Theories on Anomaly MeasurementsEmpirical Researches on Price-earnings RatioEmpirical Researches on Market Capitalization

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Efficient Market Hypothesis

Chapter 1 -Chapter 2 – Literature Review

Efficient Market HypothesisTheories on AnomaliesEmpirical Researches on P/E RatioEmpirical Researches on Size

Chapter 3 - Chapter 4 - Chapter 5 - Appendices

- Security prices fully reflect all available information in the market in an unbiased and rapid manner -

Eugene Fama (1960s)

Assumptions:(1) Large number of profit maximizers(2) New information come randomly(3) Profit maximizers adjust prices rapidly

to new information

Three forms of EMH:

Weak-form

Semistrong-form

Strong-form

Debate!!!

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Theories on Anomalies

Chapter 1 - Chapter 2 – Literature Review



Beta

Asset Return

Risk-free rate of return

SML

CAPM – Treynor (1961), Sharpe (1964), Lintner (1965), Mossin (1965)

Expected Returni = RFR + βi(Market Return – RFR)

Difference between expected returns and actual returns Anomaly

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Researches on P/E Ratio

Chapter 1 - Chapter 2 – Literature Review



Nicholson (1960) Low P/E companies

beat the market!

Low P/E Outperform

No P/E Effect

P/E Effect, but not from Low P/E

1960s McWilliam, Miller,Widmann,

Breen, Savage

Johnson, Fiore, & Zuber (1989)

Basu (1977) Low P/E still outperforms! After

several adjustments

Staff (2004) Canadian

Equity

Growth Stock

Cyclical Stock

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Holding Period Assumption

Researches on Size

Chapter 1 -Chapter 2 – Literature Review



Smallest Firms

Outperform

Size Effect = Stable over

time!

Banz & Reinganum (1981)

Brown, Kleidon, & Marsh (1982)

No Size Effect during 1967-1979 in US Equity

Predictive power of Size is unstable

Stoll & Whaley (1983)

Transaction costReinganum (1983, 1992)

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Chapter 3 - Study Design & Methodology

The Study DesignData Collection Method The Study ConstructionHypothesis Testing

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The Study Design

Chapter 1 - Chapter 2 -Chapter 3 – Study Design &

MethodologyThe Study DesignData Collection Method The Study ConstructionHypothesis Testing

Chapter 4 - Chapter 5 - Appendices

Lowest PE Low PE Mod PE High PE Highest PE

Smallest MC

M1

Smallest-

Lowest

M6

Smallest-Low

M11

Smallest-Mod

M16

Smallest-High

M21

Smallest-

Highest

Small MCM2

Small-Lowest

M7

Small-Low

M12

Small-Mod

M17

Small-High

M22

Small-Highest

Mid MCM3

Mid-Lowest

M8

Mid-Low

M13

Mid-Mod

M18

Mid-High

M23

Mid-Highest

Big MCM4

Big-Lowest

M9

Big-Low

M14

Big-Mod

M19

Big-High

M24

Big-Highest

Biggest MC

M5

Biggest-

Lowest

M10

Biggest-Low

M15

Biggest-Mod

M20

Biggest-High

M25

Biggest-

Highest

P/E EffectSi

ze E

ffect

Study Design Summary: Stocks Studied: 161 (Excluded Fund Certificates) Time Scale: Mar 1st 2007 – Mar 1st 2010 Rebalancing Period: 3 months 12 times of rebalancing Total 420 equal weighted portfolios constructed

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Data Collection MethodStock’s Prices: Closing priceRisk Free Rate: Government 5-years bond quotesQuarterly Profit: Quarterly Reports, Unit used VND 1,000Outstanding Share Number: Market capitalization divided by closing price

Eliminate Look-Ahead Bias: Date of forming portfolios chosen at the beginning trading day of Mar, Jun, Sep, and Dec for Q1, Q2, Q3, and Q4 respectively

Eliminate IPO Effect: Stock must be traded 3 months prior to the portfolio forming dates

Eliminate Survivorship Bias: Stock, which is excluded from VNIndex for any reason (switch to HNX Index, bankruptcy, etc.), is still taken into portfolios prior to the event’s date

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The Study Construction




Data PhaseTickers collected

Tickers portfoliosData Collected

P/E and Size calculated

Study P/E Effect

Study Size EffectDivide P/E by scale of 5 & reallocate

Category daily returns calculated

Synthesize returns throughout 12 periods

Run Regression each cla

ss to m

arket

alpha

Study Combination

Effect

Lowest

PELow PE Mod PE

High

PE

Highest

PE

Smallest

MCM1 M6 M11 M16 M21

Small

MCM2 M7 M12 M17 M22

Mid

MCM3 M8 M13 M18 M23

Big MC M4 M9 M14 M19 M24

Biggest

MCM5 M10 M15 M20 M25

Study Correlation of

P/E & Size

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Hypothesis Testing




Hypothesis Establishing:H0: μα = 0 – The mean of alpha is equal zeroH1: μα ≠ 0 – The mean of alpha is statistically significant different from zero

Test statistic applied: t-testPopulation variance is unknownt-test is robustt-test is more conservative to z-test

Significant Level: 0.05 level of significance

p-value approach: p-value chosen to be 5%

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Chapter 4 - Result Analysis & Discussion

P/E EffectSize EffectCombination Effect of Size and P/ECorrelation of Size, P/E & other Considerations

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P/E Effect

Chapter 1 - Chapter 2 -Chapter 3 -Chapter 4 – Result Analysis &

DiscussionP/E EffectSize EffectCombination Effect of Size and P/ECorrelation of Size, P/E & other

Considerations

Chapter 5 - Appendices

Mean Returns Standard Deviation Alpha (%) P-Value Reject?

PE1 -0.02% 2.13% 0.057815 8% Accept

PE2 -0.02% 2.13% 0.05762 7% Accept

PE3 -0.02% 2.08% 0.062083 4% Reject

PE4 -0.06% 2.03% 0.019601 46% Accept

PE5 -0.08% 2.03% -0.004459 87% Accept

Only PE3 – Moderate P/E is found to have reliable positive alpha of 0.06%

As P/E goes lower, mean returns tend to go higher along with alpha

Contradictory to Nichoson (1960), McWilliam (1966), Midler & Widmann (1966), Breen (1968), & Basu (1977)’s finding that low P/E outperform

Supportive to conclusion of Johnson, Fiore, & Zuber (1989) that there were some abnormal returns by using P/E but those not come from Low P/E

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Size Effect



Considerations


Mean Returns Standard Deviation Alpha (%) P-Value Reject?

MC1 0.02% 2.16% 0.094004 3% Reject

MC2 -0.04% 2.14% 0.037867 29% Accept

MC3 -0.02% 2.08% 0.054579 9% Accept

MC4 -0.08% 2.04% -0.006336 82% Accept

MC5 -0.09% 2.10% -0.000776 97% Accept

As Size goes lower, mean returns tend to go higher along with alpha

Only MC1’s alpha of 0.09% satisfies 95% confidence interval with p-value = 3%

Strongly supportive to Size Effect found by Banz & Reinganum (1981), Reinganum (1983, 1992), and Stoll & Whaley (1983)’s finding that low Market Cap outperform

Is this finding contradictory to Brown, Kleidon, & Marsh (1982)? Not enough evidence to conclude Size Effect in HoSE is a long-run phenomenon or time-period effect

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Combination Effect



Considerations


Mean Returns ϭ α (%) P-Value Reject?

M1 0.10% 2.39% 0.183 0% Reject

M2 -0.09% 2.35% -0.012 80% Accept

M3 -0.04% 2.38% 0.0392 42% Accept

M4 -0.07% 2.40% 0.0112 82% Accept

M5 -0.04% 2.44% 0.0527 19% Accept

M6 0.07% 2.50% 0.1525 1% Reject

M7 0.01% 2.39% 0.0894 6% Accept

M8 -0.05% 2.24% 0.0282 54% Accept

M9 -0.03% 2.25% 0.0469 28% Accept

M10 -0.08% 2.35% 0.0086 82% Accept

M11 -0.04% 2.45% 0.0373 50% Accept

M12 -0.02% 2.36% 0.0526 31% Accept

M13 0.06% 2.32% 0.1408 0% Reject

M14 -0.02% 2.21% 0.0558 20% Accept

M15 -0.12% 2.25% -0.032 33% Accept

M16 0.00% 2.40% 0.0663 27% Accept

M17 0.00% 2.40% 0.0783 15% Accept

M18 -0.04% 2.20% 0.0246 62% Accept

M19 -0.21% 2.31% -0.1285 0% Reject

M20 -0.07% 2.27% 0.0165 64% Accept

M21 -0.01% 2.38% 0.0486 44% Accept

M22 -0.06% 2.43% 0.0112 85% Accept

M23 -0.04% 2.37% 0.0366 47% Accept

M24 -0.12% 2.18% -0.0544 28% Accept

M25 -0.09% 2.27% -0.0076 84% Accept

Lowest

PELow PE Mod PE

High

PE

Highest

PE

Smallest

MCM1 M6 M11 M16 M21

Small

MCM2 M7 M12 M17 M22

Mid

MCM3 M8 M13 M18 M23

Big MC M4 M9 M14 M19 M24

Biggest

MCM5 M10 M15 M20 M25

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Correlation of Size, P/E, & Other Considerations

Chapter 1 - Chapter 2 -Chapter 3 - Chapter 4 – Result Analysis &


Considerations


MC PEMC 1PE 0 1

No Significant relationship found in the correlation between Market Cap and P/E

No significant change in results after taking transaction cost into consideration

Mean Daily Transaction Cost = (((Buy cost)*8)/(5*52))

0.000923077% = ((0.03%*8)/(5*52))

The combination effect of Size and P/E is actually come from both factors!

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Chapter 5 - Conclusion

746 Daily Observations

161 chosen

companies

Prices, # of

Share, & Quarterly

Profits

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Study Result Outperformers Adjustments?

P/E Effect Moderate class Transaction costs: No change result

Size Effect Smallest cap class Transaction costs: No change result

Combination Effect

Generally positive in smallest cap with low and mod P/E

Negative in big cap and high P/E

Transaction costs: No change result

Correlation of P/E and Size

Not recognize No

Comment on Semistrong Form EMH

Anomalies appear in smallest cap and mod P/E

Transaction costs: No change result

Chapter 1 -Chapter 2 - Chapter 3 - Chapter 4 - Chapter 5 – ConclusionAppendices

Legend: Effect is proven Effect is not proven

Conclusion Table

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Thank You for Listening!

:1009080706050403020100

00

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Appendices

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Scope VNIndex 2007 – 2010

LimitationsSustainabilityPotential of Sample Selection

Bias

Suggestions for Further Studies

a lot!

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Key Concepts & TechniquesTrailing P/E = (Price Per Share) / (Most 4 recent quarters of EPS)

Market Cap = (No. of share outstanding) x (Closing price)

Arithmetic Return= ((Port value in time T+1) – (Port value in time T)) / (Port value in time T)

Mean Daily Arithmetic Return=(1/n) x (Return Day 1st + Return Day 2nd + … + Return Day nth)

Abnormal Return=(Actual Portfolio Return) – (Expected Portfolio Return)

Split AdjustmentTicker’s returns are adjusted to 0% at the split day

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Source of InformationStock’s Prices: VNDirect

Risk Free Rate: Hanoi Stock Exchange Website

Quarterly Profit: CafeF, Ho Chi MInh Stock Exchange Website, VNDirect, & Saigon Bank Berjaya

Outstanding Share Number: Vietstocks

Economy & Finance

Size And PE Factor Toward Vietnams Stocks Return